FAO: taxadvisor.co.uk - Paying into a defined pension scheme to reduce tax band to 20%
Mr A has made a capital gain of £320k
Mr A is a 40% tax payer therefore CGT would be payable at 28% but Mr A would like to pay CGT at 18% by making his employment income only subject to 20% tax.
What he intends to do is pay salary subject to 40% band into pensions.
Option A: Opt for salary exchange/sacrifice, where the employer pays into the pension pot the sacrificed amount (in this case will be £39,200) before paying Mr A’s salary therefore, Mr A’s taxable income is reduced by £39,200 and it dealt through PAYE. As normal the employer will make its own contribution to the scheme of around £6,000, making total contributions of £45,200 in one year.
Option B: Employer continues to pay its contribution of £6,000. Mr A does not salary exhchange/sacrifice therefore he pays tax at 20% and higher band at 40%. In the last month of the tax year in say Mar-16, Mr A sends a cheque (not through employer but directly to pension provider) for £39,200 out of his savings in the bank. Mr A then claims back the tax he would have paid at 40% through PAYE on the £39,200 that’s gone into pension by submitting a tax return for FY15/16.
I understand that maximum pension contribution is set at £40,000 combined for employer and personal contributions. Mr A has unutilised allowance of £34,000 from prior tax year 14/15 which in can carry forward into FY15/16.
Are both options feasible?
In both cases would Mr A become a basic rate taxpayer in that tax year so that he is liable to pay CGT at 18% instead of 28%?
Is the answer CGT will be paid at 28% regardless because taxable income 31,461 (below) will be added to the capital gain 320,000 (below) which would then take Mr A liability into the higher 40% rate band therefore CGT at 28%?
Please advise me on the below calculations.
Capital Gain 320,000
CGT at 28% 89,600
CGT at 18% 57,600
Gross Income 80,370
Pension contribution 39,200
Revised Gross Income 41,170
Personal Allowance 10,600
Benefit in Kind 891
Revised Personal Allowance 9,709
Taxable Income 31,461
Tax calculations Basic rate 20% @ 31,461 = 6,292.20
Higher rate 40% @ 0
National insurance NI PA 8,060.00 = 0
NI at 12% 33,110.00 = 3,973.20
NI at 2% 0.00 = 0
Your questions are
Are both options relating to payments into a pension fund to mitigate income tax feasible?
The answer is yes to both. First you utilise the permitted allowance in current year and you can top up your allowance for the current tax year (6 April to 5 April) with any allowance you didn’t use from the previous 3 tax years.
CGT at 18% would only apply if the aggregate of his taxable income and capital gain keeps him within the threshold of basic rate income tax (£31,785 for tax year 2015-16)
CG is added to other income to ascertain CGT rate and it does not impact on IT rate to be applied to income. In your example taxable income being in the threshold of basic rate would suffer tax at 20& and not 40%
CGT at 28% 89,509 (319,976 x 28%)
CGT at 18% 58 ((31,785-31,461) x 18%)
They are correct
I hope this is helpful and answers your question.